The nature of creating regulation means it tends to be retrospective, outlawing conduct that has already caused harm to its victims. Financial regulators, governments and central banks are all conscious of this, increasing vigilance in order to prevent newer and more harmful behaviour.
With the emergence of new technology and tools to manage financial products, the decision was taken that the FCA should be ahead of the game, anticipating risks while tools, that could potentially end up harmful to consumers, are in development.
Taking its queue from the medical research field, the FCA launched the Regulatory Sandbox in June 2016 as part of Project Innovate, and has so far seen 60 projects go through its doors.
I'm not sure our company would be in existence without the sandboxAnna Wallace, head of innovation at the FCA, said the idea of the sandbox was to get in early with services that were trying something new in the market, with a limited test base and safeguards built in.
Ms Wallace said: "We see this as identifying the potential harm before it is widespread and being able to adapt our regulatory approach and give that feedback to a firm at a much earlier stage. The greatest trend has come from the start up community, who want to use the Regulatory Sandbox where they can work together with the regulator and understand how the regulation applies.
"The Regulatory Sandbox allows firms ways of working first before the launch of a service, with safeguards we think are appropriate. When the product goes live, we are not exactly sure how it might play out so we also work with the firm during the testing purely to spot any risks that might happen, and use our insight to see how these risks might be managed."
The way it works is that a firm applies to be part of the next cohort, satisfying requirements in being genuinely innovative and to consumers' benefit. If it is something for which there are already regulatory rules, such as for digital advice, then the more appropriate area will be the FCA's Advice Unit.
According to the FCA's report, Regulatory Sandbox: Lessons learnt, published in October last year, the vast proportion - at least three quarters - of the projects are start-ups, and half are in the area of retail banking. Over the first three cohorts, 207 firms applied to be part of the project, and applications are open for the fourth cohort.
The sandbox involves eight FCA staff members who work directly as part of the 30-strong Project Innovate, while five people work in the advice unit, also part of Project Innovate. Working on a 'hub and spoke' structure, the sandbox staff will put accepted candidates in touch with the right people, developing a bespoke testing programme.
A big part of the project is to put in place safeguards to allow the company to test its tool in a limited way. So, for example, a complex robo-investment tool may only be tested on a limited number of high-net-worth individuals, and technological assistance may be double checked by a human adviser.
Key Points
- The FCA's Regulatory Sandbox was devised to assist the development of products in a safe regulatory environment
- The regulator offers input into the product with limited authorisation
- Fintech firm found the sandbox helpful in assisting product development
A large part of the sandbox is financial services firms being able to apply for restricted authorisation, under the test. If they waited to get to market it would have to go through the process of full authorisation.
Patrick Frith, operations director of Bud, a consumer finance platform, said: "I'm not sure our company would be in existence without the sandbox. You're not working for a social media app, you're dealing with people's money, and you need to understand regulation.
"The sandbox was not a handholding exercise. They would say 'please submit your application' and we got authorised with restricted permissions, which meant we couldn't have any appointed representatives and we could have any more than 100 investors.
"It allowed us as a start up to build regulation into the product, and to understand how the FCA thinks. They wanted to see how it's going. We just needed a bit of guidance. We're talking to them and they need to understand what you're trying to achieve, and the framework is there to achieve it."
Bud went through the sandbox twice, first as a direct-to-consumer platform, where people can consolidate their finances into one place, and then as a service that can be used by banks for their customers.
"There's a misconception that you go in and can basically launch any product and the FCA will say you'll have no repercussions. You need to be very specific with the FCA."
For example, when Bud was developing its service, it was trying to steer a path between offering generic information about debt counselling and guidance, and specific advice.
"The FCA is not giving you advice or telling you what to do. They said: 'We'll get someone from the advice team' and then: 'We don't think you're giving advice' and it's really just a sounding board. If they thought we were giving advice there would have been more intervention."
Citizens Advice used the sandbox to develop a system of standardising their debt counselling recommendations in one place.
Janine Kelly, debt advice development lead at Citizens Advice, said: "The FCA was key in putting safeguards in place. I can't remember them making any specific changes other than the safeguards to put in place. We weren't allowed to test on vulnerable clients and we had to use specialist debt advisers.
"If anything controversial came up we would have pulled the pilot, but I think the fact was that what we were doing was fairly low risk. The testing showed that the concept worked, that was really positive, we could then roll it out for mainstream use and it could be used by generalist advisers."
For advisers thinking of trialing new robo-advice services, Ms Wallace said the Advice Unit may be more appropriate.
These firms, she said, want certainty in terms of how the rules apply to them.
"A lot of players in the market have come to the advice unit, using the criteria of how the law applies to their service rather than needing regulators' input," she added.
Nonetheless, for those on the outer reaches of financial services - and many of them are using distributed ledger technology, otherwise known as blockchain - the sandbox can provide useful insight from a regulation perspective, keeping its users on the straight and narrow.
Melanie Tringham is features editor of Financial Adviser
